OCR A Level Economics: Short-run costs: diminishing returns and cost curves (H460) – Revision Notes

These notes condense the short-run cost statements in Component 1, Microeconomics, of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. For full explanations and a worked table, use the study guide. Test yourself with the practice questions. Course pages: the hub and the checklist. Check your gaps with the free diagnostics. Every figure below is invented.

Short run and long run

Term	Meaning
Short run	Some input cannot be changed. Output moves only through variable inputs
Long run	Every input can be changed, so the firm’s scale can change
Fixed cost	Does not change with output. Paid at zero output (rent, hired machine, insurance)
Variable cost	Changes with output (materials, energy used, hourly wages)

• The short run is defined by what can be changed, not by a number of months.
• It differs between industries and between firms.
• In the short run a firm cannot avoid its fixed costs.

Law of diminishing returns

Statement: with some inputs fixed, adding more of a variable input eventually raises output by less and less per extra unit.

• It needs a fixed factor, unchanged technology and equal-quality units of the variable factor.
• MP falls. Total output can still rise. If TP actually falls, that is negative returns.
• It often follows an increasing-returns stage, when the first workers specialise.
• Why it happens: fixed capital, space or equipment is shared by more and more workers.
• It is a short-run idea. Diseconomies of scale involve changing all factors and are taught separately.

Product measures

Measure	Formula
TP	Total output
AP	TP ÷ number of units of the variable input
MP	Rise in TP from one more unit of the variable input

AP rises while MP is above AP and falls when MP is below AP. MP cuts AP at AP’s highest point.

Cost definitions and formulas

Cost	Formula	Notes
TFC	Given, or AFC × Q	Same at every output
TVC	Given, or AVC × Q	Zero at zero output
TC	TFC + TVC	Equals TFC at zero output
AC / ATC	TC ÷ Q, or AFC + AVC	Cost per unit
AFC	TFC ÷ Q	Always falls as Q rises
AVC	TVC ÷ Q
MC	Rise in TC ÷ rise in Q	Equals the rise in TVC

Here Q is output.

Method for a cost table

1. Write TFC. It is the same in each row.
2. Find TVC for each row from the data given.
3. Add: TC = TFC + TVC.
4. Divide by Q for AC, AFC and AVC.
5. Find MC from the rise in TC over the rise in Q between rows.
6. Check AFC + AVC = AC on one row.

Worked reminder. A small jam maker (illustrative) has fixed costs of £150 a day. At 30 jars, TVC is £210.

• TC = 150 + 210 = £360.
• AC = 360 ÷ 30 = £12.00. AFC = 150 ÷ 30 = £5.00. AVC = 210 ÷ 30 = £7.00.
• Check: 5.00 + 7.00 = 12.00.
• The 31st jar takes TC to £365, so MC = 365 − 360 = £5.00. This is below the AC of £12.00, so AC falls.

Working back from AC. If AC is £9 at 20 units and AFC is £4, then AVC = 9 − 4 = £5, TFC = 4 × 20 = £80, TVC = 5 × 20 = £100 and TC = 9 × 20 = £180.

Spotting diminishing returns in a table. A car-valeting firm (illustrative) has one pressure washer. Output with 1 to 5 cleaners is 5, 14, 22, 27 and 29 cars an hour.

• MP: 5, then 14 − 5 = 9, then 22 − 14 = 8, then 5, then 2.
• MP peaks at the second cleaner (9) and falls from the third (8). Diminishing returns begin at the third cleaner.
• AP: 5.00, 7.00, 7.33, 6.75 and 5.80. AP peaks at the third cleaner, where MP (8) is still above the previous AP of 7.00.
• If a cleaner costs £40 an hour and each car needs £0.50 of materials, MC at the second cleaner is 40 ÷ 9 + 0.50 = £4.94. At the third it is 40 ÷ 8 + 0.50 = £5.50. MC rises because MP falls.

Cost curve shapes

Curve	Shape	Reason
TFC	Horizontal	Does not vary with output
TVC	From the origin, flat then steep	Slope is MC
TC	Parallel to TVC, higher by TFC	TC = TFC + TVC
AFC	Falls, never reaches zero	AFC × Q = TFC
AVC	U-shaped	Falls with high MP, rises with diminishing returns
AC	U-shaped, above AVC	AC = AVC + AFC
MC	Falls, then rises	Mirror of MP

Order of minimum points as output rises: MC lowest, then AVC lowest, then AC lowest.

Rules

• MC below an average pulls the average down. MC above it pulls it up.
• So MC cuts AVC and AC at their lowest points.
• The vertical gap between AC and AVC is AFC. It narrows but never closes.
• The vertical gap between TC and TVC is TFC and does not change.
• Where MP is highest, MC is lowest. MC = wage ÷ MP when labour is the only variable cost.

What shifts which curve

Change	Curves that move
Rise in rent or other fixed cost	TFC, TC, AFC and AC up. MC, TVC and AVC unchanged
Rise in wages or material price	TVC, TC, AVC, AC and MC up. TFC and AFC unchanged
Better technology or training (higher MP)	MC, AVC and AC shift down

Evaluating the significance of diminishing returns

Use this chain: more variable input on fixed capacity, so MP falls, so MC and AVC rise, so unit costs rise and short-run expansion becomes costly.

Significance

• Firm: limits short-run expansion, raises the cost of extra output and may prompt investment in capacity.
• Other agents: crowded workplaces and overtime for staff, fixed-capacity public services for governments, fixed land for farming.
• Supply: higher output needs a higher price to cover higher MC.

Judgement factors

• Timescale: how quickly can capacity be added?
• Flexibility: outsourcing, shifts, hiring equipment.
• Demand: a firm well below capacity may not reach the diminishing stage.
• Technology and training: they raise MP and delay diminishing returns.

Always finish with a view: the law matters most to firms with large fixed capacity that is slow to change.

Must-know distinctions

• Diminishing returns versus negative returns: MP falling versus TP falling.
• Diminishing returns versus diseconomies of scale: one factor varied versus all factors varied.
• AC versus MC: cost per unit versus cost of the next unit.
• Fixed versus variable: depends on output, not on whether a cost ever changes.

Quick self-test

1. Define the short run.
2. Give one fixed and one variable cost for a small jam maker.
3. Output rises from 12 to 20 units and TVC rises from £48 to £80. Calculate MC.
4. TC is £250 at 25 units and AFC is £4. Calculate AVC.
5. AFC is £6 at 40 units. Find TFC.
6. MP is 8 for the 4th worker and 5 for the 5th. What does this show?
7. State the relationship between MC and AC at AC’s lowest point.
8. Why is the gap between TC and TVC constant?
9. At 10 units AC is £15. MC of the 11th unit is £19. Does AC rise or fall?
10. State two judgements that affect how far diminishing returns matter to a firm.

Answers

1. The period in which the firm has some input that it cannot change.
2. Fixed: kitchen rent. Variable: fruit or hourly wages.
3. (80 − 48) ÷ (20 − 12) = 32 ÷ 8 = £4.00.
4. AC = 250 ÷ 25 = £10. AVC = 10 − 4 = £6.00.
5. 6 × 40 = £240.
6. Diminishing returns: the extra output falls from 8 to 5, although total output may still rise.
7. MC equals AC (MC cuts AC from below).
8. The gap is TFC, which does not change with output.
9. TC at 10 units is £150, so TC at 11 is £169 and AC = 169 ÷ 11 = £15.36. AC rises because MC is above AC.
10. Any two: timescale for adding capacity, flexibility such as outsourcing, level of demand relative to capacity, changes in technology or training.

Where marks are usually lost

• Treating the short run as a calendar length rather than a period with a fixed input.
• Saying diminishing returns means output falls.
• Dividing TC by the change in output, or MC by the output level.
• Giving AFC a U shape or a minimum point. AFC falls throughout.
• Leaving the shift of a cost curve unexplained: name which curves move and which do not.
• Writing a list of effects of diminishing returns without a judgement.
• Confusing diminishing returns with diseconomies of scale.
• Not showing the formula or the working in a calculation.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. Component 1 content, Competition and market power area of study: the short-run cost statements under the market structures topic.